BLAST 11 October 2017
11 October 2017
CryptoFinance Insights: Is Bitcoin money?
Gautam Chhugani +65-6230-4654 gautam.chhugani@bernstein.com
Gaurav Jangale, ACA +65-6230-4682 gaurav.jangale@bernstein.com
We aim to educate investors on the emerging world of Bitcoin and cryptofinance. We partner with a Cryptocurrency expert and investor Ari
Paul. Ari is the Managing partner and CIO of Block Tower Capital.
Bitcoin and its underlying blockchain technology has implications
on business models across industries, particularly around
financial services and payments. However, what we find more
interesting is the relative value dynamics this industry is bringing
about between (deflationary) virtual currency and (inflationary)
fiat currency. Bitcoin now trades at ~US$4,800 per Bitcoin with
total market value of ~$80bn. It is worth delving into the very
nature and essence of Bitcoin to understand what drives its
value. Is it legal tender currency or an asset class comparable to
th
digital gold? Or is it like the 17 Century Tulip Bulbs mania as
claimed by those who call it a fraud? As market cap of the crypto
tokens increases, does it have monetary policy, regulatory and
geo-political implications? Would Wall street allocate money to
Crypto assets?
As we spent time understanding Bitcoin, we always came back to
this tweet by one of the Bitcoin core developers:
"First step to understanding Bitcoin: Admitting you don't
understand Bitcoin.
Final step: Realizing that "understanding" is a moving target."
Jameson Lopp (@lopp) February 8, 2017
In this note, we start with the most basic question Is Bitcoin
money?
Do we understand money?
To answer the question whether Bitcoin is money, we need to
first understand money. Our attempt to explain Bitcoin is
necessarily constrained by our own conditioning and
understanding of the world we grew up in. The broad narrative
we have been taught is 'first there was barter and then came
currency to make it more efficient'. We have always seen
EXHIBIT 1: Is the conventional history of money just convenient logic?
Analyst Page Bernstein Events
See Disclosure Appendix of this report for important disclosures and analyst certifications
governments or monarchies issue currency with faces of
Monarchs embossed on them. Understanding money backwards
from today is a failed exercise to start with because our
understanding of money is overly obsessed with its current
physical form and its authority from the sovereign state. As we go
through the idea behind money, we will highlight a few
characteristics so that they can be compared with the big ideas
behind Bitcoin.
Economic exchange did not wait for currency
The genesis of money lies in the concept of credit. Money before
coinage was simply 'I owe you dues' (IOU) which would be
tracked using simple accounting records. The accounting
method could be simple records, tally sticks, stone markings.
Economic exchange did not wait for coinage. People went about
trade they just recorded the value in rudimentary but effective
forms of record keeping. Coinage and standardized currency
came in much later.
For example, if A, a producer of wheat sold 1 kg of wheat to B.
Suppose, B was a producer of oranges. The accounting records
would just keep track that B owes A, but not necessarily A would
have to accept oranges in return. A is just assured that when he
needs something, B would return the favour (in oranges or not).
Literacy, numeracy and accounting was invented before money.
Money was always imaginary (using a ledger) before we made it
physical with coins and notes. This single big idea about money,
carries the maximum freight to explain the current phenomenon
of virtual currencies which are simply decentralized ledgers
secured using cryptography.
Industry Page
www.bernsteinresearch.com
Gautam Chhugani +65-6230-4654 gautam.chhugani@bernstein.com 11 October 2017

History of money as taught by textbooks

Specialisation of labour .but needs are wider than what you produce

Barter .inefficent as needs don't coincide

Currency/coinage .as medium of exchange, standardised

Bank money .multiplied money in the system

History of money discovered by anthropologists

Clearing & accounting systems .as societies still traded by keeping accounts of dues

Convenient money (salt, sugar, dried cod) . Using acceptable items of common use

Metals as money ..as metals durable, portable, divisible for long distance trade

Coinage attempt to standardize, universal value

Bank money .with original function as account clearing between merchants

Source: Money: The Unauthorized Biography (Felix Martin); Debt: The First 5,000 Years (David Graeber), Bernstein analysis
Credit and clearing systems existed before cash currency EXHIBIT 2: Stone used in Yap Island for recording dues
People engaged in trade without barter and even before coinage.
All they needed was a simple method of maintaining accounts
between parties - a simple system of IOUs. History is replete with
unique methods being used to keep tally accounts in form of
what we call a modern-day ledger. The ledger could be
maintained as markings on stones, wooden sticks, or even
markings on a wall or even large immovable stones which have
value attributed in form of credit (see Exhibit 2)
The system of IOUs have also been prevalent during recent
periods. When the Irish banks shut down for 6 months in 1970,
the economy survived on a system of private cheques /IOU
shouldered by neighborhood pubs. For 6 months, what worked
was a personalized credit system without any definite time
horizon for eventual clearance of debits and credits. In fact, even
during recent demonetization in India in 2016, we heard
anecdotes of goodwill ledgers beings used by businessmen to
settle accounts and continue trading.
Source: Wikimedia Commons
In many cases, the stone could be immovable but everyone would
still attribute credit to its rightful owner. (Stone used in Yap Island
The myth of barter
in Exhibit 2). The coins and currency are mere tokens to record
the underlying system of credit and clearing. Currency is only The notion of barter evolving to money was a convenient
cosmetic; it is the underlying system of credit and clearing that is assumption for thinkers and economists. People did not really try
fundamental foundation of money. Money in the museums has to exchange chickens for wheat because there were no matching
always been shown in form of ancient coins in copper, gold and engines back then to solve the double coincidence of needs.
silver. This vivid image of money has over emphasized the Instead, people starting storing goods of common use (e.g. salt)
token/the currency and not the underlying mechanism around it. which everyone else finds useful and hence, commodities such
If money was displayed in the museums as an old ledger, it as salt, sugar became convenient alternates to currency. History
probably would not be as interesting to look at. is filled with cases of salt, dried cod, sugar, hides, even nails
being used as currency. Thus, currency in simple terms is
something the society believes in to be acceptable universally.
Currency evolved to metals for long distance trading as metals
are durable, portable and divisible. Coinage was merely the

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Gautam Chhugani +65-6230-4654 gautam.chhugani@bernstein.com
process of standardizing and stamping the metals to be of
designated weight and size.
Monetization, universal value and creation of markets
For markets to function, there has to be a shared unit of
economic value so that participants know the language of
negotiation. Then came the process of tokenizing the coins with
standard attributed value (initial coins were just standard weight
silver, but issued coins were for example 100 drachmas).
Universal economic value is just a universal language to discuss
the value of anything. Through this process of monetization,
emerged the concept of 'market' as the organized principle of
prices and the language to express ambition, greed, and
entrepreneurship.
Transferability and negotiability
Money is credit due (IOU) but it needs to be transferrable credit.
Money has value, when you expect others to accept it. It needs to
be transferable in an open market. Thus, for any party to accept
an IOU, there should be trust that any third party will be willing to
accept the IOU i.e. there is a liquid market for it to be
transferable. Thus, appeared bank money. Banks in their early
forms became clearing house of debt between merchants.
Onset of bank money with trust being reposed in centralized
banks
Banks first started as merchant clearing houses. Once a bank
had endorsed the credit/IOU, it would become transferable in
the market based on the faith in the large clearing houses. In
simple terms, Banks could issue IOU to depositors and receive
IOU in form of receivables. We look at banks as lending
organisations today, but banks' original function was this clearing
function.
Role of the sovereign state
As we have seen by now, money is a system of credit, that is
liquid, transferable and trustless. Sovereign states became more
important, maintaining large armies, protecting societies and
thereafter provision of public goods and services against which
they would collect taxes. Sovereign governments (regardless of
form) became a significant part of the national output and thus
largest source of payments in the economy.
This economic prominence of the sovereign state only meant that
money issued by the sovereign facilitated the trustless, liquid
market where the citizens would trust the money issued by
sovereign. Today, we assume that currency needs to be issued
by the sovereign state; however, it is not the sovereign stamp, but
the trust and universal acceptability feature that gives currency
its value.
INDIA FINANCIALS
11 October 2017
Money, as we understand now has the following core
functionalities:
Credit clearing mechanism or a simple ledger (often
maintained by banks and intermediaries in modern times)
Portable, durable, divisible
Transferable, trust and faith (often comes from the
sovereign endorsement)
Standard universal value (though politics/economics/monetary
policy has often impacted value of money by inflating (printing)
/deflating money)
Bitcoin: Can you create value from thin air?
Cryptocurrency (e.g. Bitcoin) is best understood in form of 3
layers:
Blockchain (ledger and clearing systems)
Protocol (crypto based monetary policy and incentives
establishing trustless network)
Tokens (Portable, durable, divisible, transferable)
Blockchain the ledger and clearing systems
The blockchain is a shared ledger, which keeps a permanent,
immutable record of digital transactions. The ledger is
decentralized i.e. a copy of the ledger is maintained across
multiple computers across the globe. The Computer nodes are
called miners; it would be easy to think of them as book-keepers
who verify the transactions and agree on the state of the ledger
that needs to be carried forward. For performing the ledger
verification service or the bookkeeping services, they are
rewarded in Bitcoins (also called mining Bitcoins).
The protocol the new crypto based monetary policy
Protocol is a set of rules that nodes in a network use to transmit
information. Transmission control protocol (TCP) is the set of
rules to exchange information packets on the internet. The
Internet protocol (IP) is the set of rules to exchange messages at
the internet address level.
In the context of blockchains and particularly Bitcoin, because
the information is a form of digital financial transaction, the
protocol becomes a set of rules to govern the identity, security,
economic incentives of the digital transactions on the Bitcoin
network. The identity and security of the transactions and the
ledger is established through cryptography both at the account
holder level (through public/private key crypto rules) and at the
level of Miners/book-keepers to maintain security and
authenticity of the ledger simple to build consensus on the
state of the ledger. These set of crypto-economic rules could be
seen as the new monetary policy. Further, the Bitcoin blockchain
BERNSTEIN 3
Gautam Chhugani +65-6230-4654 gautam.chhugani@bernstein.com 11 October 2017

is so designed that the supply is capped at 21 million bitcoins

(with the maximum supply reached in the year 2140). There are
What gives bitcoin value?
currently ~16.6 million bitcoins with an exponentially decreasing
inflation rate thus the bitcoin protocol is considered to be Its tempting to value Bitcoin relative to companies or
deflationary in nature. commodities with related value propositions. The value of top 4
global payment networks aggregates to ~$550 bn; the worlds
The trust, security and transferability of the Bitcoin come from
gold supply is worth roughly $7 trillion vs. Bitcoin's market cap of
the set of crypto-economic rules that are part of the Bitcoin
~$76 bn. While these comparisons are useful starting points,
protocol. It clearly obviates the need of a central authority to
they fall short.
validate transactions centrally.

Monetary transmission or a new economy?

Tokens are like bearer cash
Some of Bitcoins value does indeed come from its usefulness for
The token native to the Bitcoin blockchain network is called
payments or monetary transfer. Early advocates of Bitcoin
Bitcoin. Other blockchains can have their own tokens e.g. Ether
suggested it would be adopted by merchants to avoid
is the intrinsic token to the Ethereum blockchain network. Tokens
chargebacks, or that it would displace traditional money transfer
are used as economic incentives/disincentives to reward the
services by providing cheaper and faster remittances. Bitcoin
miners / users as part of the network.
currently allows the user to transfer large amounts of money in
th
The Bitcoin token is divisible to the 8 decimal. It functions as about 10 minutes for about $2, an attractive alternative to wire
bearer cash. You just need to know the public address of the transfers or international remittance services. However, nothing
receiver to send it it is permission-less just like how cash prevents existing financial institutions from offering even faster
currency is in the physical world. If you want to buy anything off and cheaper transmission services. Bitcoin is valuable in this
the shelf, you just need to hand over the cash. Similarly, to regard only for censorship resistance. Payment networks can
transfer Bitcoin, you just need to know the public address of the block payments to a particular company for example and bank
receiver. The white paper on Bitcoin by Satoshi Nakamoto regulators can ban wire transfers to a particular country or
(unidentified individual or a group) refers to Bitcoin as electronic company. In contrast, it is near impossible to prevent an owner of
peer to peer cash. It intends to build a mechanism to make bitcoins from transferring them to a third party of their choice.
payments over a communication channel (just like we send
In fact, Bitcoin could be seen as virtual 'bearer cash' economy
information on the internet) without a centralized trusted third
supported by a decentralized 'trustless' network a new crypto
party.
economy with its own protocol or policy. The faith of its citizens
software developers, miners, investors, early individual and
sovereign state adopters would drive the value of that network.
Governance issues in absence of central authority
The value of the new economic network can be related to the
To change or upgrade the Bitcoin network software sometimes
transactions in the network as reflected in Exhibits 3 to 4
requires a hard fork. A hard fork is a change in the network
protocol that renders it incompatible with older versions of the
software. A hard fork may be uncontentious and viewed as a
Bitcoin could fluctuate daily (as high as 5-10% per day) for it to
welcome software upgrade by the entire community, or it may be
be stable money, although it is in its early days. Fiat money is still
contentious. In a contentious hard fork, some people running
the final form of settlement governments still collect taxes in
Bitcoin software may install new incompatible software, while
fiat money and salaries are still paid in fiat money. Thus, for now
others remain on the old network; this can result in two
Bitcoin has only emerged as a 'censorship resistant' asset class.
competing blockchains that are forks of the previous chain. On
st We will delve deeper into Bitcoin and its cryptographic cousins in
August 1 , Bitcoin forked into Bitcoin and Bitcoin Cash. In
the coming editions.
November, there may be another fork in which there may be two
blockchains each claiming to be Bitcoin. Some investors fear
this could produce confusion and hurt investor confidence, while
others see it as the cost of decentralized governance.

While, it emerges that Bitcoin does share some of the core

functionalities of money secure clearing mechanism, divisible,
portable, transferable, secure and trustworthy (crypto-economic
rules), the most intriguing part is its value? How do we know it is
worth ~$4,800 as it stands today?

INDIA FINANCIALS BERNSTEIN 4

Gautam Chhugani +65-6230-4654 gautam.chhugani@bernstein.com 11 October 2017

EXHIBIT 3: Evolution of Bitcoin in terms of its market value and

processed transaction value

Bitcoin: Matket cap vs. Transaction

Value, in USD bn
90 1.60
80 1.40
70 1.20
60
1.00
50
0.80
40
0.60
30
20 0.40

10 0.20

0 -

Transaction value, RHS Marketcap

Note: Estimated USD transaction value taken from Blockchain.info

Source: Willy Woo, Chris Burniske, Blockchain.info, Bernstein analysis

EXHIBIT 4: Bitcoin Network Value to Transaction ratio

Bitcoin: Network Value to Transaction

Ratio (NVT)
350x

300x

250x

200x

150x

100x

50x

0x

Note: The above ratio has been smoothed

Source: Willy Woo, Chris Burniske, Blockchain.info, Bernstein analysis

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Gautam Chhugani +65-6230-4654 gautam.chhugani@bernstein.com 11 October 2017

DISCLOSURE APPENDIX

TICKER TABLE
9 Oct 2017 TTM EPS Reported P/E Reported
Closing Target Rel.
Ticker Rating Price Price Perf. 2017A 2018E 2019E 2017A 2018E 2019E
HDFCB.IN O INR 1,795.50 2,430.00 21.3% INR 59.16 71.98 89.11 30.35 24.94 20.15
MXAPJ 538.87 30.59 37.14 40.86 17.61 14.51 13.19
O - Outperform, M - Market-Perform, U - Underperform, N Not Rated

MXAPJ base year is 2016;.

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Gautam Chhugani +65-6230-4654 gautam.chhugani@bernstein.com 11 October 2017

VALUATION METHODOLOGY
India Financials
India is a growth market and investors generally seek growth-based returns in India. We believe all banks in India trade on what market
believes as the sustainable earnings growth momentum. Banks that have sustained cross-cycle earnings growth despite sector asset
quality concerns trade at a premium. On the other hand, banks that have been inconsistent in earnings growth get penalized by the market
until they build investor confidence again. We value our coverage on a target P/E multiple based on one year forward earnings calibrated by
trading history and our expectation of three-year sustainable earnings growth. We use a one-year forward multiple based on FY'19 earnings
to arrive at FY'18 end target price. We corroborate our target price earnings multiples with a P/BV based multiple as a secondary check. We
also believe the market can be brutal with growth stocks if the growth story shows any structural weakness and thus we constantly stress-
test for structural growth weakness across our industry and company investment thesis. This methodology works for banks under NPL
stress too as we expect earnings to largely normalize by FY'19

RISKS
HDFC Bank Ltd
HDFCB faces significant margin pressure beyond our expectations in line with industry trends
HDFCB is unable to drive operating leverage and scale across its retail lending business to enable significant costs savings in operating
expenditure
HDFCB has to meaningfully slow down credit cards and personal loan book growth due to unexpected risk concerns

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Ticker Rating Changes
HDFCB.IN O (IC) 11/16/16

Rating Guide: O - Outperform, M - Market-Perform, U - Underperform, N - Not Rated

Rating Actions: IC - Initiated Coverage, DC - Dropped Coverage, RC - Rating Change

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investments may fluctuate, and investments that are denominated in foreign currencies may fluctuate in value as a result of exposure to exchange rate movements. Information about past performance of an investment is not
necessarily a guide to, indicator of, or assurance of, future performance.